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Tuesday, April 15, 2014

My own personal feelings on budgets as it relates to government is more nuanced than the traditional conservative (I hate government spending and taxes) versus liberal (I love - or at least support - government spending and taxes).

I generally lean slightly conservative when it comes to my own personal budget. I've never been one to use a credit card much or to hold a large balance (I once did that, but I learned my lesson). I spend within my means. My means being my take home income. My means would be nearly infinite of course if I had a printing press and could otherwise create "Garth bucks" and get people to accept those as currency. But alas I don't have that power.

States, like my home state of Indiana, are in similar boats. Indiana is quite a bit larger than me though financially speaking and has a lower credit risk and it can issue its own bonds for funding in times where taxes may not be strong enough to support government spending, but long-term, State governments have to balance their books (either by statute, or out of necessity because they have limited credit availability). Like me, Indiana can't create and issue its own "Indiana bucks." Because of this, I generally prefer my State to be a bit conservative when it comes to its spending habits.

Then there is the federal government. The federal government is massive - it's a fifth of our entire economy (give or take). It makes spending decisions, but almost always runs a deficit. And it can do so into perpetuity. Like States, it issues bonds, but unlike a State the US government has its own monopoly control of its currency that it itself issues, which has a significant demand on the market because it is accepted as currency - the most powerful currency on Earth. Because of this monopoly control of its own currency, the Federal government does not need to "fund" its spending via taxation. In fact, in general, the decision to spend federal funds is made independently from the decision to tax. That may sound odd to people that think that our taxes go directly to 'fund' our federal spending, but that's the way it is. The use of taxes to fund spending is an optical illusion that gets perpetuated in the media - liberal or otherwise.

So what purpose does taxation at the federal level serve? Well, largely it's to modulate private spending demand. (I would argue a secondary but significant purpose is income redistribution to regulate economic inequality) When taxes rise, resources are taken from me, Indiana, and other entities that have limited funding sources because we don't control our own currency. Because of that, our spending demand shrinks. Contrarily, when taxes fall, resources are given to me, you, and Indiana, and our demand to spend some or all of that money rises. The fact that the government has changed the taxation level at the federal level need not have any bearing whatsoever on the federal decision to spend - it effects the private decision to spend greatly however, and in that way, regulates spending demand and inflation. This is a fundamental difference between the US government compared to individuals and States (and even the European Union countries like Greece that also do not have control of their own individual currency).

I feel like many of our political disagreements would be better served by understanding these nuances as it relates to taxation. My fear is that the media and political extremists have made it virtually impossible to have an honest examination on the different role of taxes at different entity levels. It's just all black and white to them. Taxes are good or evil depending on the political persuasion, and that unfortunately does nobody any good at the end of the day.

Garth Brazelton

About Me

I work for the Indiana Economic Development Corporation as the Director of Operations and Business Systems, and I teach macroeconomics at Indiana University (Indianapolis). Previously, I was an Economist at the US DOT in Cambridge, MA. This blog does not represent the opinions of any of these organizations.